INVESTING

INVESTING; Appliances And Music: Best Buy's Prospects

By MICHELLE LEDER

Published: February 18, 2001

Correction Appended

VALUE investors who bet on the Best Buy Company late last year were richly rewarded: after dropping to $22.31 on Dec. 8, the stock doubled in less than six weeks.

But now investors in the company, a fast-growing consumer electronics and major appliance retail chain, are wondering what is next. Analysts and money managers are divided over whether the company's shares can return soon to reflecting the 20-percent-plus profit growth rates that Wall Street had come to expect from Best Buy, which is based in Eden Prairie, Minn., and is known for its huge stores, 413 in all.

''One day, this stock is going to be trading in the $60's and $70's,'' said Gary Balter, a managing director at Credit Suisse First Boston, who has a strong buy recommendation and a 12-month target of $60 on the stock. ''The question is: When do you buy it?''

Not long ago Best Buy was trading at that target -- and higher. Known for its efficiency -- sales per square foot of $893 outshine those of its closest competitor, Circuit City Stores, where the comparable figure is $571, Mr. Balter estimated -- Best Buy's stock hit a 52-week high of $88.87 last April. But it ended the year down 41.2 percent, plunging 39 percent on Nov. 9 alone, when Best Buy executives surprised Wall Street by announcing that its third- and fourth-quarter earnings and revenue would be well below expectations.

Worries over weak holiday sales and a Circuit City warning on profit margins and sales contributed to the swoon. So did Best Buy's decision to spend $685 million, including $260 million it borrowed, to buy the bankrupt, 1,370-store Musicland chain.

At its low, the stock was trading at just 12.5 times 2001 fiscal-year earnings estimates that had been reduced to $1.78 a share. The company is expected to report fourth-quarter earnings in the last week of March. Its accounting year ends on March 3.

After the free fall of Best Buy's stock, David Dreman, chairman of Dreman Value Management, which manages the $3.7 billion Kemper-Dreman High Return Equity fund, took a 1.5 percent position in the company. His price per share was in the high $20's, but he has not added to his position. ''The stock was much more attractive a month ago,'' he said. ''I'd love it if we got another wave of fear.''

While most people, including Mr. Dreman, do not expect the stock to fall to those levels again, concern about the economy and the Musicland purchase could keep the stock relatively flat for a few months, analysts and money managers said. Even if the economy picks up, the large-appliance business remains tricky. Last fall, Circuit City, the nation's second-largest retailer of such appliances, behind Sears, Roebuck, said it was abandoning that market.

And Home Depot and Wal-Mart Stores, both known for competing on price, recently began selling large appliances in some markets.

According to the Consumer Electronics Association, appliance sales are expected to rise 6 percent this year after a 10 percent increase in 2000.

''Best Buy had a nice run, and I wouldn't be surprised if it backed off a bit,'' said Todd Kuhrt, a senior analyst at Midwest Research in Cleveland. Indeed, after jumping to $49.80 at the end of January, Best Buy stock has slid back, closing at $40.01 on Friday. Mr. Kuhrt is neutral on the stock even though he has a 12-month target price in the high $40's.

While Mr. Kuhrt says Best Buy got a good deal on the stores that operate under the Sam Goody, Suncoast, Media Play and On Cue names, all acquired in the Musicland deal, he worries that it could take awhile to make them profitable and that mastering the different retail concepts in the Musicland chain could be challenging.

THE store formats for the two companies are vastly different. Best Buy executives are familiar with operating huge, 45,000-square-foot stores in large metropolitan areas, while Musicland operates much smaller stores, typically in malls, that tend to sell CD's and videos, which are heavily discounted by many other retailers.

Laurie Bauer, a spokeswoman for Best Buy, said that the company was not surprised by Wall Street's poor reaction to the Musicland deal and that company executives had worked hard to explain their rationale. In particular, Ms. Bauer said, Musicland's 200 On Cue stores -- 6,500-square-foot stores in rural areas -- will expand Best Buy into a new market. Musicland's other stores, she said, should also help attract more women and younger shoppers.

Timothy M. Ghriskey, senior equity portfolio manager at the Dreyfus Fund, said he believes that the Musicland deal will be a plus for Best Buy. ''Long term, the Musicland deal is a great thing, because it's a nice way to extend and expand without the major capital expense,'' said Mr. Ghriskey, who invested 0.23 percent of his fund's assets in Best Buy just before the stock collapsed in November. ''But any transition is difficult.''

Still, he said, the stock's potential is strong: ''If you look out 9 to 12 months, this is a good place to be.''

Graph: ''Rival Retailers'' shows Best Buy's stock has outperformed its closest competitor in the last year. (Source: Bloomberg Financial Markets)

Correction: February 25, 2001, Sunday An article last Sunday about investing in the Best Buy Company, the retailer of consumer electronics and appliances, referred incorrectly to the financial condition of Musicland Stores, a company it acquired on Jan. 31. Musicland renegotiated agreements with creditors and suppliers in 1997; it was not bankrupt.